Compensation & Benefits Alert
On September 21, 2017, the Securities and Exchange Commission (SEC) issued an interpretive release and new/revised C&DIs to assist companies in their efforts to comply with the pay ratio disclosure requirement. The guidance provides valuable assistance and needed clarification and comes in time to meet the upcoming 2018 proxy deadlines.
The guidance substantially eases the burden of the CEO pay ratio disclosure as mandated by the 2010 Dodd-Frank financial reform law. Section 953(b) of the Dodd-Frank Act directed the SEC to amend Item 402 of Regulation S-K to require each issuer to disclose the following (with limited exceptions):
In August 2015, the SEC adopted its final rule, implementing the Dodd-Frank provision. Under the final rule, companies are required to disclose their pay ratio in proxy statements or Form 10-Ks filed starting in 2018. After a request for public comments due to "unanticipated compliance difficulties" encountered by some companies, the SEC communicated that implementation of the rule would not be delayed but that guidance would be forthcoming to provide flexibility and to help reduce the cost of compliance.
Commission's Interpretive Guidance
Enforcement Guidance: Use of Reasonable Estimates and Statistical Samplings
The new SEC guidance reinforces the notion that the pay ratio rules afford increased flexibility to issuers in determining appropriate methodologies to identify the "median" workforce. According to the guidance, as long as an issuer uses reasonable estimates, assumptions or methodologies, the Commission will not seek an enforcement action unless the disclosure was made without a reasonable basis or not provided in good faith. The examples provided by the Division of Corporate Finance suggest that any sampling method may be chosen provided that that is reasonably representative of the employee population, based on the issuer's knowledge of the workforce distribution across jurisdictions, composition of full-time and part-time employees, distribution of employees among typical occupations, and the issuer's pay structures for typical occupations.
The additional guidance clarifies that issuers may use a blend of statistical sampling and other reasonable methods to identify the median employee, such as simple random sampling, stratified sampling, cluster sampling and systematic sampling.
New C&DI Q/A 128C.06 also provides that companies can specifically describe their pay ratios as an estimate in their disclosures (assuming that such a statement could be made in good faith).
Use of Internal Records
The interpretive release and revised C&DI Q/A 128C.01 state that an issuer may use internal records that reasonably reflect annual compensation to identify its median employee, even if those records do not include every element of compensation, including equity awards widely distributed to employees. Previously, C&DI Q/A 128C.01 provided that total cash compensation could be a consistently applied compensation measure, unless the issuer widely distributed equity awards.
The SEC interpretive release clarifies that the provision in the rules indicating that the definition of "employee" does not include workers who are employed and whose compensation is determined by an unaffiliated third party describes just one category of workers that is expressly excluded from the definition of "employee" under the rule. This provision was not intended to serve as an exclusive basis for determining whether a worker is an employee or not and an issuer may use widely recognized tests under another area of law (such as employment or tax law) to determine whether its workers are employees or independent contractors. The previous guidance provided by C&DI Q/A 128C.05 (now withdrawn) stated that an issuer had to include workers whose compensation it determined, regardless of any classification made under tax or employment laws. Using this guideline, issuers can utilize methodologies that they would otherwise employ to determine which workers are employees or independent contractors in other legal and regulatory contexts.
The pay ratio rule currently permits issuers to exempt non-US employees where these employees account for 5% or less of the issuer's total US and non-US employees, with certain limitations. The interpretive release clarifies that an issuer may use appropriate existing internal records, such as tax or payroll records, in determining whether the 5% de minimis exemption is available.
Ability to Substitute Identified Median Employee
The SEC in the interpretive release reiterated its prior view that if an issuer determines that there are anomalous characteristics of the identified median employee's compensation that have a significant higher or lower impact on the pay ratio, the issuer may substitute another employee with substantially similar compensation to the original identified median employee based on the compensation measure it used to select the median employee.
The SEC expanded the flexibility afforded by the pay ratio disclosure rule. The latest guidance should alleviate some compliance costs and administrative burdens for many issuers.
Now that the pay-ratio rule is confirmed to be in place for reporting in 2018, it is rather unlikely that Congress will take any immediate action that would preclude pay-ratio reporting or otherwise lead the SEC to reconsider the pay ratio rules.
We are continuing to monitor developments on this front and will provide updates to the extent additional guidance is issued.